How do Treasury bills work, and how do you buy them?

A Treasury bill (T-bill) is a short loan to the US government that lasts 4 to 52 weeks. You buy it for less than its face value, get the full face value back when it matures, and the difference is your interest, which is free of state and local income tax.

Backed by the US government

Treasury bills are debts of the US government. They are not FDIC insured, because they are not bank deposits, but they are backed by the government that issues them.

Bought at a discount

Bills are sold at a discount to face value, or sometimes at face value. You don't get interest payments along the way. You get the face value when the bill matures.

Rates are set at each auction

There is no fixed T-bill rate. Each auction sets a new price, so the rate changes week to week with short-term interest rates. TreasuryDirect posts results for every auction.

Taxed federally only

T-bill interest is subject to federal income tax but exempt from state and local income taxes. It is generally reported for the year the bill matures or you sell it.

How a T-bill earns interest

With a savings account, the bank adds interest to your balance. A T-bill works the other way around. You pay less than the face value at the start, and the government pays you the full face value at the end. A $10,000 bill bought for $9,810 pays $10,000 at maturity, so you earned $190.

The price is set at auction from a discount rate, using a formula TreasuryDirect publishes. You don't need to do the math yourself. When you place a bid you won't know the exact rate, but after the auction you'll see the price you paid per $100 of face value.

Terms and how often they're sold

Bills come in seven terms: 4, 6, 8, 13, 17, 26 and 52 weeks. The shorter terms are auctioned every week, and 52-week bills every 4 weeks. The minimum purchase is $100, and you can buy more in $100 steps, up to $10 million in a single auction with a noncompetitive bid.

If you want to hold bills for longer than a year, you can line up several terms or choose reinvestment so one bill rolls into the next. Each new bill gets the rate from its own auction, which may be higher or lower.

Buying on TreasuryDirect

TreasuryDirect is the Treasury's own website. You open a free account, link a bank account and place a noncompetitive bid for the term and amount you want. The money comes out of your bank account on the issue date, and the face value lands back in your bank account when the bill matures.

The catch is selling early. Bills bought on TreasuryDirect must be held at least 45 calendar days before you can transfer them. To sell before maturity, you transfer the bill to a bank or broker and sell it there. Plan to hold TreasuryDirect bills to the end.

Buying through a brokerage

Most brokerage accounts also let you buy T-bills, either at auction or from other investors. Buying at auction there works much like TreasuryDirect. A brokerage also lets you sell a bill before it matures, at whatever price the market pays that day.

That price can be more or less than you paid plus the interest earned so far. It tends to be lower if rates have risen since you bought. Ask your brokerage whether it charges any fee for buying or selling Treasuries.

T-bills vs CDs and savings

All three are very safe homes for cash. Savings lets you withdraw any day. A CD and a T-bill both lock a rate for a term, but a CD usually charges a penalty to break it, while a T-bill can be sold at a market price.

The tax break is the main reason to pick T-bills. In a state with a 5% income tax, $190 of CD interest loses about $10 to state tax, while $190 of T-bill interest keeps it. In a state with no income tax, compare the rates directly.